The carnage wrought in several sectors of the Chinese market (tech, educational and luxury brands) over the last weeks as a result of government diktat has been widely reported. With few exceptions the commentary is bearish and the news from China suggests that further pressure is being brought to bear: earlier in this week Tencent sought to display it credentials as a good corporate citizen by announcing that it will be limiting the time that youngsters can spend glued to its games to 3 hours a week.
We wrote on the issue in July (Chinese regulation – is it the end of the gravy train?) and cautioned that some of the policies being discussed would undermine certain business models. However, having been covering the Chinese stock markets for the last 30 years, we did point out that sporadic regulation aimed at tempering capitalist exuberance or excess was nothing new. Our experience shows that whilst radical policy changes are difficult to predict, picking the companies with robust models is still possible and allows investors to profit.
The continued share price weakness since we last wrote has prompted us to revisit the subject and highlight further examples of erstwhile successful companies that have been in the cross hairs of government scrutiny. We now know that several other companies have been on the receiving end of regulatory censure: one of the largest social media network companies, a now global ecommerce platform which supports the livelihood of hundreds and thousands of SMEs and a couple of tech companies which have already penetrated the everyday life of millions of consumers.
The names of these companies??? “Well, off the record, on the QT and very hush hush”*, the stocks concerned are Facebook, Google, Amazon, Apple and Microsoft!!! In other words, government regulation is not just a Chinese phenomenon but a global one – D.C. and the European Commission have been conducting antitrust enforcement since late 1990s. Each of the aforementioned companies have been facing antitrust lawsuits – Microsoft was fined USD 1.4bn in 2008 and market cap increased 7x since then; Apple paid a fine of US$15bn in 2016 and its market cap has since tripled in value. The share prices of the others following similarly hefty fines have, when looked at over the medium term, hardly missed a beat. As investors, our experience is that top class companies with leading technologies and business models remain great investments notwithstanding periodic sanctions. What doesn’t kill you it seems can indeed make you stronger.
That being said, we do not ignore major policy changes in China: the initiatives announced in the education sector have clearly undermined many private sector businesses. Whilst we have no doubt that given the priority ascribed to education private tutors will remain in high demand it is difficult to see how the provision of these services provided by publicly listed companies can be feasible.
A direct read across from US/EU regulation on the one hand to the sanctions announced in Beijing on the other may be an extrapolation too far, but the damage done to the prices of good quality companies supplying the consumer with innovative services and products now look interesting (Tencent, Meituan, Bilibili are all down between 40-50%). Sentiment still gusts to the negative but there are signs of a price level being reached in some of these stocks with attractive valuations for investors willing to look beyond the short term.
Having reduced our exposure in China from 55% at the beginning of the year to just over 30% today, we are not intending to reverse this imminently, but we are scrutinising the opportunities increasingly positively.
One last word on the differing perceptions between international and domestic Chinese investors to these regulations. The latter seem less concerned as evidenced by much more modest falls in local indices than those referenced by the former. Government policy on “common prosperity” in China appears to have more resonance at home than abroad. We shall be writing on why this might be the case shortly.
*Sid Hudgens played by Danny DeVito in the film ‘L.A. Confidential’, 1997
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A version of this article was published in Wealth DFM Magazine
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